According to researcher GFMS Ltd., world investment demand in silver blasted 40% higher in 2010, to 279.3 million ounces. Industrial demand, a more predictable driver, only increased by about 21%.

I get that investors consider precious metals “safe havens” and a monetary alternative. And in light of recent world events, it’s obvious why demand is perking up. Especially for silver, as the run in gold prices makes it the more affordable precious metal.

However, investment demand is notoriously fickle. If it wanes even the slightest for silver, look out below. I say that because silver supplies aren’t exactly limited right now. On the contrary, in fact… a surplus exists.

Surplus Lures Speculators… But Beware the Fallout

At the end of last year, silver’s surplus – defined as the difference between supply and fabrication demand – checked in at 173.4 million ounces. Looking ahead, Barclays Capital estimates 2011 to be “another year of record supply,” thanks to increased mining activity.

Simple economics lend credence to the prediction, too. As market prices increase for any commodity, so does the incentive for producers to generate more. And with primary silver mining cash costs checking-in under $6 an ounce, I’d say there’s ample incentive to ramp up mining efforts.

As Philip Klapwijk, executive chairman of GFMS, said, “There’s no convincing economic reason for why this [silver rally] is happening. It’s still a market with a very large surplus.”

And that’s precisely why investors should proceed with caution.

A Correction Could Be Swift and Severe

According to The Silver Institute, investors plowed $5.6 billion into silver in 2010, almost doubling 2009’s total. But there’s no reason why this money that poured in can’t stampede out just as quickly.

Case in point: When the financial crisis hit in 2008, silver tanked almost 50% in just four months time. (By comparison, gold prices fell about half as much).

The fact that the bulk of silver investments are currently being made in highly liquid, exchange-traded products, like the iShares Silver Trust (NYSE: SLV), increases the odds of a swift and severe correction. (Last year, investors bought 494.98 million ounces of silver via exchange-traded products versus 101.3 million ounces of coin and physical silver.)

And if ever there was an indication of at least a short-term peak in prices, it’s “cash-strapped people lining up to sell their silverware,” as Barron’s reports:

In New York’s diamond district on Friday, a scrap-silver dealer had his arms full. “We’re getting more business than ever before,” he said, as he emptied the contents of a garbage bag one customer brought in – silver bowls, cups, a platter, an ashtray, forks, spoons and more.

Not to be overlooked, a number of large hedge funds have “joined the [silver] party,” according to Ole Hansen, a senior manager at Saxo Bank. Remember, hedge funds aren’t invested in silver as a safe haven. They get paid to speculate. And when they go from being net buyers to net sellers in order to cash in on the profits, other investors are bound to follow suit.

Bottom line: Investment flows have been the largest driver of silver prices over the last year. And when it comes to putting my hard-earned capital at risk, I prefer to put my confidence in compelling fundamentals, not the fickle whims of other investors.

Comments (15)

Some good points here, but the article fails to mention JPM-Chase and the many lawsuits filed by investors for market manipulation; this was even admitted to by former CFTC commissioner Bart Chilton.

Silver’s historical sub-twenty dollar an ounce price may have been the result of price suppression via JPM manipulation. In other words silver may have been under valued for years and is now coming closer to it’s true value regardless of the current investor speculation.

I think some of this acticle is rubbish. We’re in a whole new world. There are other major variables that were not noted in the article, which Louise must already know about. (Gold/silver 16:1 ratio disparity, US Fed/inflation, possible USD currency change in the world, continuing unrest in the middle east, China and other countries hoarding gold/silver, I dissagree with the over-supply argument as we’ve just seen backwardation recently). My prediction is that the hedgers and specs will not affect the market to the extent that she expects. If it does “correct”, what a great buy-in opp. If there is another pullback, my leveraged money is on a very small one and I’m buying in all the way to around 80/oz.

i was wondering u said silver could actually be going closer to its true value, and i was wondering could the same thing be true with gold? I inherited six Kruger-rands and am now reconsidering selling them.

Gold and silver tend to move in the same direction, if one goes up or down the other follows but percentages are different. So yes if/when silver makes another climb gold should move up as well. Silver has corrected ( was manipulated down-again) and may go lower (gold too) but I don’t believe it will stay low for long before anther sharp rise. I would not sell unless you need the funds. If you do sell consider buying silver-it’s upside is greater.

Hmmm interesting article, but what if this doesn’t happen? Allot of the rules seem to be breaking when it comes to trying to work out what way the price will go – many people thought there would be a dip and held off from buying only to see the price rise drammatically. Only time will tell I guess….

In addition to John’s reply above your article neglects to mention the historic au/ag ratio which substantially overshot and has, for the last year been moving back to its mean. Also if, as GFMS says, there is adequate supply, why has there been no silver (except scrap) available at any of the refiners in India since April 1? Can you say manipulation? Oops.

At least part of the rise in silver prices is the weakness of the ever expanding dollar trail. Each new one that is printed lessens the value even more. Silver may go down, but I doubt speculation is as reliable a driver of the price as the weak dollar is. Gold is climbing rapidly as well. Real money (gold and silver) always reassert themselves when fiat currencies fail.

People who own physical are hoarding an illiquid asset. When the speculators holding semi-liquid paper silver leave the room, the hoarders will be looking for a buyer amongst themselves. After all, we all know the price of housing can only go up, regardless of the price today.

The hoarders are telling us that all the dollar denominated prices are wrong, only the price of silver is right. All we need is a financial blip and the sellers will pile up at the very small doorway looking to convert to a liquid asset, the dollar. The perplexing part is that the hoarders are preparing for this day by buying silver and pushing the price up while saying the dollar is trash. People simply do not understand how economies run by speculators transfer wealth.

Why was JPM suppressing the price of silver? They haven’t been doing a very good job of it. Also, I think people are spending too much time looking a graphs that project 50 years into the future. If anything happens like that, we would be in collapse far sooner and that is not going to happen. The worst thing that could happen is 100% employment as we go back to making things when the China deal sours. China has high unemployment which makes it’s society price sensitive and like America, it has wealth disparity putting pressure on wages and ultimately it’s ability to consume production. We are sending production and technology outward bound. If China hiccups, there will be financial collapse here and it won’t be because of the dollar. It will be caused by the crazy house of cards business structure we are creating based on a short term profit worldview.

Your article didnt touch on several key factors. Andrew Maguire’s confirmation of GATA’s claim on the previous manipulation. One might assume that perhaps less manipulation is now occurring since the whistle blower has spoken. The physical market is going absolutely through the roof because folks want insurance against Ben Bernanke’s policy of devaluating the dollar by the $600B qe2. Physical bullion spread is now about $4 more than the paper. There are delivery’s which are being settled in FIAT at much higher levels than the spot because there isn’t enough physical at the comex. Look At the trend in inventories at the comex. Silver will surpass $50 an oz quite soon…I pray that I’m wrong but the dollar seems doomed and that is the reason for the silver market upheaval.
As far as silver being illiquid, it’s been money for thousands of years. Judas was paid 30 pieces this week a couple of thousand years ago. The Fiat dollar has only been around since Richard
Nixon and it is trending away from being the world’s reserve
currency. China and Russia are starting to trade directly without going through dollars. Foreign governments are discussing other options than the dollar. Citizens are fed up and are bartering. Meanwhile, to help the Ben, the Feds are jailing Patriots like Von Nothaus that put Ron Paul’s face on a silver round saying its counterfeit to a US coin. States governments are taking matters into their own hands and are considering other forms of legal tender. These are the reasons that some of the Sheople are opting out of the paper FIAT and going with the classic form of money. We are disgusted. We are buying the physical now. Maybe, just maybe the Republic or the States will get it under control and stop the spend and print.
What did the founding fathers say about a private bank like the (not)Federal Reserve printing our currency instead of Congress coining it? Something about our children being homeless on the
land that their fathers conquered because of the private banks controlling the currency (inflation and deflation) and thereby Depriving the property of its Citizens.

Speculation drives every single investment in the world. This is a BAD thing? I see — only when it applies to a non-fiat currency that will hold value. I wish I was a central banker… I could print all sorts of money out of thin air to prevent people from using other currency, through the use of paid-for propaganda. Nice try buddy.

Well this article was written a month ago, and though I do not agree that speculators are driving silver higher (as the correlation to the falling US dollar is too clear), the correction has been swift and sharp as the article predicted.

Onward and upward from here however, now that the most fickle speculators have headed to the next pet investment.